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Perceive mixed outlook ahead

NALCO’s Q2FY23 EBITDA of Rs3.3bn (down 70% YoY) missed estimates owing to the double whammy of lower volume and higher cost, primarily at aluminium (Al) division. Key takeaways: 1) Profitability of both chemicals and Al division was lower YoY; however, in case of chemicals division, there was a sequential recovery; 2) Al sales volume was down 14% YoY to 109kte; 3) working capital increase of almost Rs5bn constrained the operating cashflow; and 4) incurred capex of Rs11.7bn for accelerating growth projects. Going ahead, we perceive a mixed outlook for the company. The cost efficiencies from higher proportion of captive coal and ramp up of caustic soda plant (under JV) are likely to be offset by subdued LME Al prices. We reinitiate coverage on NALCO with HOLD. Factoring in the benefits of lower cost, but risk from lower LME Al and alumina price, we value NALCO at 4.5x FY24EV/EBITDA (mid-cycle level) resulting in TP of Rs76/share.

* Subdued performance on cost/realisation woes: NALCO’s EBITDA of Rs3.3bn (down 70% YoY) undershot consensus. Key takeaways: 1) Al division sales volume was down 14% YoY (5% QoQ) at 109kte though production volume remained stable at 115kte (Ministry of Mines data) possibly as a combination of lower export opportunities and muted domestic demand; 2) Al EBIT was sharply down (78% YoY/QoQ) at Rs1.7bn mirroring sharp dip in LME Al price; down 10% YoY/17% QoQ. Besides, coal cost continued to stay elevated; 3) alumina EBIT at Rs875mn (Q1FY23: Rs(71)mn) recovered sequentially despite lower alumina prices owing to caustic soda cost coming off; and 4) as a result of Al inventory accretion and reduced payables, working capital build up in H1FY23 was Rs5bn, restricting cashflow from operations (pre-tax) to a mere Rs1.6bn (H1FY22: Rs16.8bn). Going ahead, we believe operationalisation of captive coal mining operations at Utkal D block and ramp up of caustic soda plant in JV with GACL will aid cost; however, lower LME Al price is likely to put pressure on revenue, keeping margins constrained.

* Keeping a tab on captive coal block materialisation and ramp up of caustic soda plant: In our view, cost efficiencies are expected to play a major role amidst lower Al prices. While slurry project and increased transportation through rail are likely to lower logistics cost, we believe operationalisation of Utkal D- block is critical for lowering the cost sustainably. Besides, ramp up of caustic soda supply from GACL is likely to insulate the company from the price fluctuations of this critical input for chemicals business. As a result, we are raising our EBITDA margin estimates to 17.7% (Q2FY23: 9.6%) despite our assumption of range bound LME Al and alumina prices.

* Outlook- at the crossroads: In our view, the threat of lower realisation is likely to be offset by lower coal cost as Utkal D block commences operation. At CMP, we perceive balanced risk-reward. Hence, we reinitiate coverage on NALCO with HOLD recommendation and TP of Rs76 on 4.5x FY24E EBITDA. Further delay in coal block operationalisation is a key risk to our thesis.

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